Posted by: Josh Lehner | August 4, 2022

Consumers Holding Strong

Just a quick update on household incomes and consumer spending. Last week the June 2022 U.S. income and personal consumption expenditure data were released. As expected, both show strong nominal gains, which were mostly eroded by the current high rate of inflation. On in inflation-adjusted basis, personal income excluding government assistance saw a small decline, while consumer spending eked out a small increase. It’s really been remarkable to see how strong household finances and consumer spending have been so far this year. On the left you can see total, nominal spending continues to grow at rates much stronger than the pre-pandemic trend. On the right you can see how this increase in overall spending is really just due to higher prices, and the real, or inflation-adjusted spending is basically right on the pre-pandemic trend.

This ongoing strength is one reason why it is unlikely the economy has been in recession so far this year. However we are starting to see households tap into the savings they built up earlier in the pandemic. Since the start of the year, our office’s estimate of excess savings is down about 6%. Note that overall savings continues to increase, but it is now increasing at a slower rate than it has been, which is why this measure of excess savings is dropping a little bit. Even so, it is clear that consumers — at least in aggregate — have plenty more firepower to continue to spend if they so choose, or need to to continue to put food on the table and make rent.

Closer to home we lack such timely data. The BEA will release 2022q2 state income data at the end of September, and 2021 state consumer spending data in October. But fear not. We do have one real-time measure of consumer spending that isn’t subject to sampling error or revisions: weekly video lottery sales. In recent months these sales have been on an ever-so-slight downward trajectory, and remain well above pre-pandemic sales so far.

One possibility could be that inflation, and high gas prices in particular are starting to crimp household budgets, especially on discretionary spending like gaming. I believe there is some truth to that. Given how inequitable we know income and wealth is in America, the topline household savings data likely overstates the typical household situation. However that is hard to know at the moment. We know wage growth continues to be strongest among lower-wage jobs and industries. And recent comments made by Visa and MasterCard were a bit contradictory in terms of spending patterns among high- versus low-income cardholders.

That said, another possibility is that this decline in video lottery sales is due to some combination of federal aid running out which had provided a temporary boost, and consumers choosing to spend a bit more of their entertainment dollars on other activities that may have been restricted earlier in the pandemic. This could include formal restrictions or informal choices to avoid airplanes and crowds. In fact, this scenario is exactly what our office has built into the lottery forecast for some time now. This slowdown in sales in recent months is right on track.

Of course disentangling these two big possibilities is challenging in real time. Forecasting is humbling. And you can be accurate for the wrong reasons. Today I am leaning towards some combination of the two, but still mostly the second given increasing strength in travel and entertainment more broadly. We know household’s spending on gas was at a record low before Russia’s invasion of Ukraine, but the big run-up in prices still impacts household budgets in some way, even if the biggest adjustment was spending out of savings or taking on more credit card debt as opposed to cutting back on other items.

Bottom Line: To date consumers are holding up well. The strong household finances built up during the pandemic are allowing spending to continue apace even in the face of very fast inflation. Now, consumers are not increasing the quantity of their purchases much, but rather are paying more for the same items. Even the overall shifts seen in terms of goods vs services, or even gaming are modest in the context of the current macroeconomy and bout of inflation.

Now, at some point consumers may grow weary or burn through their reserves, leading to an outright drop in spending. But for the time being, this has not happened in aggregate. It usually takes job losses, or the fear of losing one’s job for consumers to slow their spending. Given the tight and strong labor market, we are not there yet, even if labor income is slowing. And looking forward, does the recent drop in gas prices free up more room in the budget to spend on other items again, or allow households to rebuilt their savings a bit?

Posted by: Josh Lehner | July 28, 2022

Labor Income is Slowing, Probably

We know the economy needs to cool to bring inflation down. It’s the reason the Federal Reserve raised interest rates yesterday and are expected to continue to do so in the months ahead. Inflation is not costless, and as Federal Reserve Chair Powell says, price stability is the bedrock of the economy. A key factor here has been that labor income is booming. That was great as we dug out from the recession and the federal aid expired. However here’s part of what our office wrote in our most recent forecast document:

The issue is consumer demand and the ability to spend is outstripping the economy’s ability to produce enough goods and services. When too many dollars are chasing too few goods, prices rise. The combination of higher interest rates, cooling of goods prices, and moderating household financial conditions should all work to slow inflation in the economy this year and next. It is an open question just how much inflation will slow. The ultimate risk is the economy needs higher interest rates to truly wring inflation out of the system.

What matters here for the macro economy are aggregate household finances. In terms of labor income that is a combination of jobs, hours worked, and hourly pay. Some slowing here is simply mechanical. Job growth will slow in a full employment economy simply because there aren’t many unemployed workers to hire. And some slowing is more expected due to forecasted changes in the economy such as average wage growth decelerating as firms are less desperate for workers as they staff up.

To be honest, so far the signals that this is happening are mixed at best. Job growth has slowed a bit nationally, but monthly job gains in Oregon haven’t really. Initial claims for unemployment insurance are up just a hair and job openings down a little, which points toward somewhat slower net job gains in the future. And different wage measures are doing that thing where they, well, differ with some showing deceleration (average hourly earnings) and others continued acceleration (Atlanta Fed’s wage tracker). Tomorrow’s Employment Cost Index for the second quarter will be another important wage data point to follow closely. It will be strong, but just how strong is the question.

And yet, here in Oregon we are seeing the expected deceleration in withholdings. Growth in withholdings over the past year has slowed to broadly in the range we experienced pre-pandemic. They are no longer in double-digit territory. Now, in terms of potentially goofy math, in recent weeks we are comparing revenues to the peak growth rates from a year ago, which itself was exactly a year removed from the worst of the initial pandemic and shutdown impacts. As such it is possible that the true deceleration in the economy is less pronounced than this chart indicates, but time will tell.

Of course withholdings are not purely just wages. There are some withholdings out of retirement accounts, bonuses, stock options and the like. So it can be a bit harder to know exactly how much of this slowing is tied to those sorts of reasons versus the fundamental underlying slowing the economy needs to cool inflation. If it is more fundamental, then expectations are the jobs reports and other labor market data in the coming months should begin to show the same patterns. The next steps would then be less strains on supply chains as consumer demand cools, and underlying inflation in the economy begins to move in the direction of the Fed’s target. And despite today’s GDP numbers, it is unlikely the U.S. economy has been in recession the first half of the year, even as our office is on Recession Watch given the risks from all of these dynamics.

Posted by: Josh Lehner | July 20, 2022

Oregon’s High-Tech Sector (July 2022)

High-technology is a pillar of Oregon’s economy. Overall it accounts for about 5% of statewide jobs, but due to its higher productivity and pay, the sector is 11% of overall wages paid and 11% of state GDP. Given the strong growth in recent years, the sector’s employment today is now at an all-time high, surpassing even the bubbliest of peaks of the dotcom era more than two decades ago.

Much of the gains seen in the past decade are driven by the fast-growing software side of the industry. Even as Oregon as a whole has a smaller concentration of jobs at software firms than the nation, that is not the case in Portland. And when it comes to tech talent, a look at software and related occupations, the Portland metro area consistently ranks around the 90th percentile. That means the share of the local workforce in these types of jobs is larger than it is in 90% of all metros around the country. Even so, such jobs are growing across the state, and possibly more so in the years ahead due to increased working-from-home opportunities.

Oregon’s relative high-tech strengths continue to be in hardware where our local concentration is among the highest in the entire country. For much of the past 20 years, hardware manufacturing has seen large investments in new technologies, but on net has not added many new jobs. To the extent some local firms were hiring, others, mostly from the older generation of firms, were contracting. Then the fact that Oregon has been passed over for the 4 major announcements for new fabs certainly seems like a missed opportunity. And it is a missed opportunity, with the final impacts still to be determined depending upon the ultimate nature of these new facilities in Arizona, New York, Ohio, and Texas.

Now, what may have been missed in all of this is the fact that Oregon’s hardware sector, and semiconductors in particular are booming today. As pointed out by Christian Kaylor from the Employment Department, since the beginning of 2021, semiconductor firms in Oregon have added well over 4,000 jobs, an increase of nearly 15 percent. To help frame that number, that’s equivalent to if Oregon got 2 of the 4 new fabs located here. So the overall strong demand for chips, and increased importance of domestic manufacturing during global supply chain struggles and geopolitical upheaval certainly seems to be bearing fruit for our regional economy.

Today, Oregon semiconductor employment is about 1,000 less than the all-time high reached in 2001 just as the bottom dropped out. Oregon’s share of the national semiconductor workforce today is 9%, whereas we were 5% back then. In general, it is clear that Oregon has been gaining marketshare over the years, even before the recent strong growth.

Looking forward we know that durable goods manufacturing is typically very volatile over the business cycle. Even with the strong underlying demand, underproduction of automobiles, and increased importance of domestic manufacturing and supply chains, we know households usually have the ability to time their durable goods purchases. Most of us do not need to buy a new car, computer, or house tomorrow even if we may want one. In times of economic uncertainty, and the fact that higher interest rates make big ticket purchases more expensive, and high inflation eats into household budgets, some cyclical declines whenever the next recession comes should be expected. Even so, these gains are not being driven by irrational exuberance or bubble-like dynamics.

Bottom Line: Expectations are for steady hardware employment in Oregon in the years ahead. Even as the new fabs elsewhere come online, Oregon’s share of the national industry will remain high, and likely higher than it was pre-COVID. All of that said, software will continue to be the major driver of growth in terms of new firms, employment, and overall tech talent.

Update 7/21: The huge rise in start-up valuations nationwide in recent years, followed by the more recent crash and decline in VC funding is starting to impact the software side of the industry with some layoff announcements. This is something to keep any eye on, but should be more of a short-term issue than a fundamental, long-term issue. On one hand, with Oregon receiving a slightly below average share of VC funding, it means the fallout could be less severe locally than, say, in the Bay Area. On the other hand, the main risk our office identified back in 2015 is that when your local economy has a lot of outposts or satellite offices and not as many HQ operations, you may be more vulnerable in a downturn when businesses cut the spokes and consolidate at the hub.

The full set of high-tech slides from our office are below.

Posted by: Josh Lehner | July 14, 2022

Inflation, Recession, and Leading Indicators

Inflation continues to run very hot. Yesterday’s June consumer price index data release was larger than expected, and expectations were for a big increase given the run-up in gas prices last month. Over the past year, CPI is running at a 9% pace. This is the fastest since 1981. You can slice and dice the data myriad ways, but at a high level it is clear that underlying inflation, what you get when you start to strip out the impacts of the pandemic reopenings, overloaded supply chains and more recently the oil shock, has accelerated over the past year or so. Some relief on headline inflation is likely coming in the next couple of months as gas prices are falling today, supply chains are improving, and consumer spending on goods slows. However it is the look at the underlying trend, and to the extent it becomes more entrenched in the overall economy and inflation expectations, that is most worrisome to the Federal Reserve.

We know that inflation is not costless, and that inflationary economic booms traditionally don’t end well. The challenge is right now we have slowing economic growth combined with high inflation and rising interest rates. This creates dynamics that can lead to a recession, especially if the Federal Reserve has to continue to raise rates to head off inflation even if the economy weakens further. Given the Fed has met the employment side of its dual mandate, their entire focus is on inflation. They are actively communicating that they are willing to induce a recession if needed to ensure inflation comes down.

Anytime economists start throwing around the R word, we risk whatever comes next out of our mouths being our famous last words. So while recession risks today are uncomfortably high, it is very unlikely the U.S. economy is currently in recession based on available data which is primarily through May at this point.

Let’s first talk about what a recession is. The National Bureau of Economic Research (NBER) is the official arbiter of recessions and they define it as a broad-based decline in economic activity that lasts more than a few months. A recession is not the sometimes used rule of thumb of two quarters of negative real GDP*. Rather the NBER looks at a handful of key metrics to gauge the depth, diffusion, and duration of changes in the economy. Our office regularly updates these key NBER metrics, as seen in the first set of charts below. On the left you can see that jobs and production are continuing to increase. On the right you can see that despite the fastest inflation in 40 years, consumer spending and household income are eking out some small gains on an inflation-adjusted basis. (Note that the data here is through May, with June’s big increase in prices, we are likely to see some inflation-adjusted declines when the spending data is released later this month.) Overall, it is hard for the economy to truly be contracting when jobs, incomes, and output are all increasing in the most recent data.

UPDATE 7/15: June industrial production data was released today. It shows a decline last month, along with revisions to previous months that slow the overall growth in industrial production.

The data shown above, that the NBER uses to determine when recessions begin and end, is subject to revisions but are the best data we have showing what is currently happening in the economy. To get a better idea of what is coming in the months ahead economists turn to leading indicators.

There are two main composite leading indicator series for Oregon. The UO Index of Economic Indicators is developed Tim Duy at the University of Oregon, and the Oregon Index of Leading Indicators (OILI) is developed by our office. These indexes are red light/green light measures, so the data moving sideways is less worrisome than it may seem. What matters are outright declines on a sustained basis. We are not their yet, and the Conference Board’s U.S. leading economic index isn’t quite either.

In terms of individual components there are always ups and downs. One of the benefits of composite indices is that each individual indicator may not perfectly lead each cycle but when all the tea leaves are combined, the overall index should. Right now the indicators are a mixed bag but most point toward an ongoing expansion. The only indicator included in OILI that has truly tanked is consumer sentiment (but consumers are still spending even if they are pessimistic.) New Incorporations are slowing off of multi-decade highs and housing permits are holding steady throughout the pandemic.

Bottom Line: Based on the current data, the U.S. economy is unlikely to be in recession. And traditional leading indicator series are not plunging. Given the pessimism built into the economic conventional wisdom today, this should be comforting. However, we know the current dynamics of slowing growth, high inflation, and rising rates presents the Fed with a very challenging situation. The vibes are off. As such, our office is on Recession Watch.


Note: Keen-eyed observers may have noticed that here on the blog our office retired the COVID-19 tracking page and created a Recession Watch page last month. There is more data and detail over there. We will likely update the page once or twice a month as new data comes out.

* Let’s get this out of the way. The U.S. economy looks likely to experience two quarters of negative GDP this year. First quarter 2022 was already negative, but it’s important to note that this was due to idiosyncratic reasons. The economy did not actually contract. Consumer spending and business investment increased to start the year. However, in GDP accounting the big increase in imports, and a decline in inventories drove the overall headline numbers negative. Here in the second quarter of 2022, the expected decline — we get actual data on 7/28 — is likely to be driven again by inventory declines, but also a pullback in residential investment in the face of the mortgage rate increases, and the fact that inflation is taking a bigger bite of nominal consumer spending than it did previously. As such, a decline in the second quarter will be more of a traditional decline in GDP, and/or sign of stagflation. Again, just to reiterate, an official recession is not two quarters of negative GDP. The U.S. very likely has had two such quarters to start the year, and yet employers have added 2.7 million jobs over the same time period. This cycle is different in so many ways.

Posted by: Josh Lehner | July 8, 2022

Update on State Economies

Happy Friday everyone. Just a quick update on the economic recoveries across the country and how Oregon stacks up. We know that Oregon suffered a pretty typical recession compared to other states, whereas we normally are more volatile when we look across recessions historically. One question was if we did not see a larger than average recession this time, would we still experience the typical stronger expansion or would Oregon be more in-line with the rest of the states. The jury is still out on that, but we are starting to get more data to do a proper comparison.

Right now, it’s clear that Oregon’s labor market recovery is right in-line with the typical state. As of the first quarter, Oregon’s payroll employment was 1.8 percent below pre-pandemic peaks. Oregon’s recovery ranks 28th highest across all states and DC. Numerically this is two tenths of a percent below the median. With the slowdown in population growth and the fact Oregon was a two shutdown state due to public health policies — which did achieve better health outcomes — this should not be unexpected as of today. Our office’s expectations are that as population growth rebounds this year and next, Oregon’s relative employment performance should improve in the years ahead.

Turning to economic output — or in the case of state GDP it is officially a value-added measure — Oregon fares a bit better than most states. Today, Oregon’s state GDP stands 3.2% above the pre-pandemic peak after accounting for inflation. This ranks 18th highest across all states and DC.

Lastly, but most importantly for all of our pocketbooks, Oregon’s personal income growth shows the strongest relative performance across these high level metrics. Today personal income in the state is 15% above where it was prior to the start of the pandemic. This ranks 15th highest across all states and DC. Oregon’s income growth continues to be above average and is translating into higher wages for workers, and higher household incomes across the entire distribution.

The two main reasons Oregon’s economy has historically been more volatile than the typical state is due to migration and our industrial structure. These factors could be working in opposite directions moving forward, although we shall see. In terms of slowing, we know goods-producing industries are more sensitive to interest rates. As rates increase due to Fed policy trying to head off inflation, we could see a slowdown in construction, manufacturing, and natural resources. Our forecast is for very modest gains in these industries moving forward as a result. To the upside, population growth should be rebounding today and in the years ahead. This will provide a larger labor force for local businesses to hire and expand from, even as demographics make the labor market structurally tight. Over the long run, it’s really that faster population growth that drives Oregon’s faster economic performance. We will get 2022 population estimates from Portland State in November, and from Census in December.

Posted by: Josh Lehner | June 29, 2022

State and Local Pandemic Revenues

It’s no secret that the inflationary economic boom has translated into very strong public sector tax revenues. It’s the reason Oregon is currently facing a record kicker. These strong collections are nationwide and not a local phenomenon. 49 states saw revenues come in above projections this past year.

The combination of an underlying strong economy and sharp increases in non-wage forms of income, like corporate profits and capital gains, means that state and local taxes as a share of personal income are higher today than any point in recent memory as seen in the latest edition of the Graph of the Week. The chart focus on the big 3 taxes that state and local government levy, as regularly published by the Census Bureau.

That said, there is tremendous nuance and variation here that is worth spending a minute discussing.

First, some of these really strong gains are clearly temporary and will either fall or more likely crash back to earth in the quarters and years ahead. This is not a permanent shift to higher taxes but rather reflects pandemic factors and/or taxpayer behavior. The typical state is forecasting General Fund growth of just 1.2% this upcoming fiscal year, which will bring revenue as a share of income lower. Our office’s forecast is for a year-over-year decline in General Fund revenues coming off such highs.

Second, general sales taxes will retreat as consumer spending shifts back into services to a greater degree. Even if spending on goods holds steady in the years ahead, spending on goods as a share of income and as a share of overall spending will decline. This will impact most states’ sales taxes which generally only apply to physical/retail goods and not services. This will not be the case in Oregon where our new(ish) corporate activity tax (CAT) applies to goods and services alike. Policymakers designed Oregon’s CAT to be more immune to the tax base erosion other states have experienced in recent decades. Retail deflation will further erode sales tax revenue in the years ahead.

Third, due to property tax restrictions in quite a few states, property taxes are growing, but not seeing the same sort of growth as underlying economic activity, let alone property valuations would suggest. In Oregon, it is likely property taxes as a share of income are declining.

All of this brings me to my main point. There is tremendous variation between state and local government revenues today, and really across different local government jurisdictions all based upon their mix of revenues.

For instance, if we look across the country, about 90% of income taxes are state revenues versus 10% going to local governments. Similarly sales taxes are roughly 75% state and 25% local. So the biggest categories of public revenues, and the ones growing the most during the pandemic are primarily state resources and not local. On the other hand property taxes are 97% local and only 3% state.

As such, jurisdictions that are only or primarily funded by property taxes are seeing the slowest revenue gains. This is the basis for the title of the chart. States are seeing stronger revenue gains while some local jurisdictions without diverse revenue streams are seeing weaker.

Now, local governments’ revenues overall are roughly 1/3 transfers from the federal and state government, 1/3 property taxes, and 1/3 everything else. So local government revenues are growing, in part due to the large ARPA transfers and shared state revenues, and most of the things in the all other category are growing too, even if property taxes are growing slowly, especially in a state like Oregon.

At a high level, every public entity is facing the same inflation and cost pressures, and the same tight labor market now that full employment is here. However some jurisdictions are seeing correspondingly strong revenue growth — some even get to keep it to provide public services — while other are seeing solid gains but that are making ongoing budget choices more challenging than you might think.

Update: one macroeconomic implication is that strong state and local revenues, and accumulated reserve funds will offset some of the declines in federal spending after the pandemic programs ended last year

Posted by: Josh Lehner | June 21, 2022

Priced Out Oregon Households

The housing market has been overheated during the pandemic. Between strong household finances and demographics, demand has outstripped supply. The result is both for rent vacancies and for sale inventories are low. Rents and home prices have increased considerably.

The mortgage rate shock so far this year is changing the housing market dynamics. 30 year mortgage rates have risen from around 3% at the end of 2021 to just over 6% in recent days. When combined with ongoing price appreciation, this means the cost of a mortgage payment has increased 40-50% in just a handful of months.

The impact here is that the potential pool of homebuyers for the median priced home has been effectively cut in half as seen in the latest edition of the Graph of the Week. It used to be that more than 1 in 3 households in the Portland region could afford to buy the median home but that has fallen to less than 1 in 5 at today’s prices and interest rates. Our office estimates that 168,000 Portland area households have can no longer afford the typical home sold based on these changes. In the Bend metro area only about 1 in 10 households can afford to buy the median home sold today, a reduction of 9,000 households compared to just a few months ago.

Update 8/4/2022: Mortgage rates have fallen down to around 5% in recent days. The following chart updates the analysis based on the latest sales price data available and a 5.1% mortgage rate. Overall this is a relative improvement in affordability in the past month or so, but still a large change from the beginning of the year.

There are a lot of implications from this erosion in ownership affordability.

First it means less demand to buy homes today. Or at least fewer qualified buyers. Fed Chair Powell said the housing market needed a reset. Our office’s baseline outlook is for sales to drop in the months ahead. Price appreciation will slow considerably. Housing starts are likely to decline in the back half of the year. (Nationally, builders are seeing more cancellations and having to bring back incentives and price reductions.) That forecast was developed 6-8 weeks ago and mortgage rates have risen even further since, meaning that these market changes could end up being more pronounced than anticipated. We shall see how financial markets evolve in the coming weeks.

Second, for sale inventories will increase. In Portland, active residential listings are up 19% when looking at May 2021 to May 2022, however May 2022 was still the second lowest May on record. Inventories are still about half of what they were in the years leading up to the pandemic. So even, as inventories rise and there are more buying opportunities, there may be more price pressure than you might think looking at interest rates alone. We are just moving away from such an extreme seller’s market to something that’s at least a bit more balanced. Ultimately how far the pendulum swings is still to be determined. These changes usually take time to develop and with inventories coming off of record lows there is a long way to go.

Third, we know these affordability changes impact credit-sensitive buyers much more. This includes younger households and first-time homebuyers who need to finance their home purchase. Investors and long-time homeowners who have a lot of equity are less affected as they do not necessarily need to fully finance a purchase. See our office’s recent Twitter thread for more charts on these generational/demographic impacts.

Fourth, this means increased demand for rentals and ongoing rent increases as potential buyers are priced out. Whether these rental price increases ultimately result in reversing the increase in household formation during the pandemic is still unknown. It is also possible that the rental stock will increase as some builders who cannot find individual buyers will turn toward the Build For Rent market to offload properties.

Finally, there are a few things we don’t know or haven’t seen yet in the data. Just how strong are finances for middle- and upper-income households? Are they able to weather these higher costs more easily than you might think? How quickly will seller expectations and the market rebalance to this new reality?

Portland area home sales are down just a little bit in April and May on a seasonally adjusted basis. But we have yet to really see the impacts of the higher rates in the data. This is generally true across some other West Coast markets. Given these markets are underbuilt overall, it could be that they are a bit less sensitive to these changes than some inland markets. Even so, Oregon is not immune to these changes and overall dynamics. Data in the coming months should show the impacts.

Bottom Line: Our office’s long-standing concern is our lack of housing production. Worse affordability impacts Oregon household’s every day, and could slow future economic growth due to fewer people being able to move here and increase displacement risks. While the recent run-up in mortgage rates is problematic for those looking to buy or sell a home this year, it is likely to be more of a temporary adjustment period in the big picture. Longer-term we know housing demand will be solid given income growth and demographics. Oregon needs to see continued gains in new construction.

Bonus Graph of the Week. I tried. I promise you I really tried to keep this to just one chart but after I put this together I couldn’t keep it out because it tells an important part of the story. As Altos Research’s Mike Simonsen says, one key metric to watch are price reductions. If price reductions are more common that’s indicative of lower effective demand at today’s prices, and that buyers are running into their invisible price ceiling as Zonda’s Ali Wolf calls it. Today there are more price reductions than there have been in years in the Portland market, but again, coming off these really low rates of the extreme seller’s market. Note how the price reductions are accelerating during the spring selling season this year, whereas they typically peak late summer or early fall for those who missed out selling during the peak season.

(Note that Zillow only has weekly data for the largest 100 metros so we do not have other Oregon data besides Portland to compare.)

Posted by: Josh Lehner | June 16, 2022

Boom/Bust Alternative Scenario

“Inflationary booms traditionally don’t end well.”

Mark McMullen, State Economist

That was Mark back in our forecast release in February. Since then inflation has continued to stay elevated, and inflation expectations are creeping higher. Yesterday we saw a noticeably more hawkish Federal Reserve in terms of their outlook and expected policy path moving forward.

As Fed Chair Powell says, a sustained economic expansion requires price stability. One of the challenges is that the near-term economic path looks pretty much the same regardless of if we are headed for the soft landing or the recession as part of a boom/bust cycle. We need to, and currently are seeing tighter financial conditions taking some of the froth out the stock market, housing cool noticeably from its overheated pandemic days, and consumer spending shift back into services and out of goods. Even as the economy is delivering the things we need to see to get the good outcome, the pessimism overall is growing. As we noted in our most recent forecast, recession are in part psychological events driven by what John Maynard Keynes called “animal spirts.”

With that in mind, let’s take a look at the Boom/Bust alternative scenario our office has been incorporating into our forecast for the past year. Now, the baseline outlook is still the most likely path for the Oregon economy, and the baseline remains the soft landing and a continued economic expansion. However, our office believes the most likely alterative path for the economy is some sort of stronger boom this year followed by a bust in the next year or two.

Keep in mind that this is a stylized scenario. The economy is unlikely to unfold exactly as described here but this sheds some light on the potential causes and consequences of such a scenario.

Boom/Bust Scenario:

The inflationary boom continues. By late this year, employment, income, and spending are all 2-3 percentage points higher than the baseline. Corporate profits are up even more. The unemployment rate drops to 3 percent by late summer or early fall. Inflation cools from today’s highs but remains closer to 5 percent. The Federal Reserve raises interest rates more aggressively. The policy goal is to cool the economy and bring inflation under control. However, the end result of raising interest rates high enough to actually slow inflation is to send the economy back into recession beginning in 2023. Depending upon the exact timing of the Federal Reserve policy changes, the recession may be pushed out into 2024.

In any future recession, the key will be the severity of the cycle. Today, there is relatively little leverage in the economy. Household debt remains tame, and the labor market is structurally tight, although a recession would make it cyclically weak for a period of time. Without clear imbalances, or leverage in the economy, any ensuing recession is likely to be mild or moderate, and less severe. One risk here is just how entrenched inflation is in the overall economy. A more severe recession would likely be needed to wring out more entrenched inflationary pressures, whereas a milder recession may be needed if most of today’s inflation is transitory, or temporary.

In this boom/bust scenario, Oregon suffers a moderate recession. The state loses 100,000 jobs and the unemployment rate rises to nearly 9 percent. Nominal personal income does not necessarily decline significantly, but rather stalls out for a year and a half or two years. This type of cycle would be similar to the aftermath of the dotcom bust here in Oregon in the early 2000s.

Another key consideration is the relative starting point of the bust. With an economy growing faster than expected this year, the fallout from a recession, when compared to the baseline, is somewhat less severe. In the upcoming 2023-25 biennium, employment and total personal income in Oregon are about 4 percent below baseline.

Growth resumes in early 2025 and the recovery is strong. Oregon’s economy regains full employment and catches up to the baseline outlook in 2027 or 2028.

The revenue implications of the Boom/Bust economic scenario a larger projected kicker this biennium as revenues continue to boom. The ensuring recession after the Federal Reserve hikes interest rates to head off inflation takes a toll on state resources. Revenues in both 2023-25 and 2025-27 are considerably below the baseline outlook. Declines would also be seen among Lottery sales and the Corporate Activity Tax revenues as well as consumers spend less during recessions.

Posted by: Josh Lehner | June 8, 2022

Oregon Construction Outlook, June 2022

Oregon’s construction outlook remains solid in the years ahead. Our office’s employment forecast calls for moderate gains due to the fact the industry is at historic highs today, and the underlying volume of work moving forward should be fairly steady in the big picture. There are a number of balls in the air at the moment that are trying to look at what it would take for Oregon to increasing housing production. Our office will share more when available. But for today let’s take a quick look at a few pieces of the overall industry.

Oregon’s construction workforce is about half residential and half nonresidential. Of course many contractors work on both types of projects, but in terms of the primary nature of their individual businesses this is how the data shakes out. Residential has certainly been more boom/bust over recent cycles, whereas nonresidential is a little more stable in part due to public works.

In total, the construction industry has about a 10% wage premium relative to the statewide average wage. However this masks considerably different wages across occupations and different segments of the industry. Nonresidential construction workers on average make $86,000 per year which is 34% above the statewide average. On the other end, residential construction workers on average make $54,000 per year which is 15% below the statewide average. These differences are important to keep in mind when talking about attracting and retaining workers, or growing the construction workforce to increase housing starts and the like.

Finally, an updated look at our office’s expectations for construction spending by broad category in the years ahead. These spending numbers are adjusted for inflation to get a better gauge of underlying volume of work, but it’s imperfect in that regard.

In terms of the outlook, broadly speaking it’s fairly similar to the last time we dug into it. We should get official Census state nonresidential figures for 2021 any day now. But so far the declines nationally are less pronounced than first feared. It may still be some time before we start building new offices and hotels in our urban cores which weighs on the outlook, but both food and beverage, and amusement and recreation are picking up. Health care should too when hospital finances improve again with more elective surgeries. Warehousing has been astronomically strong but the industry is likely to slow moving forward. Manufacturing has seen strong gains lately as well. All told, nonresidential is doing well even if there are specific weaknesses.

Residential construction will be fine in the years ahead. Our office’s forecast for housing starts are for moderate gains overall, and home improvements should remain strong given the record setting home equity that owners have. However, we do have a year-over-year decline forecasted for 2022 given the mortgage rate shock. It will take some time for buyers to adjust to the new interest rate environment. Monthly payments on new mortgages is through the roof relative to just a handful of months ago. We have seen U.S. new home sales drop, and builder cancellations are starting to rise some. These are expected to be relatively short-term impacts (this year) as the market adjusts, but they should feed into fewer actual housing starts in the months ahead. However, over the coming years, we know housing demand is strong and both housing starts and construction activity will increase.

Lastly in terms of public works there are a few risks to the outlook. Public revenues are quite strong, providing policymakers funding for projects should they so choose. We also have the federal infrastructure bill that passed last year. Those impacts have more of a mid- to late-2020s timing as it takes awhile to get projects designed and up and running. On the other side we have difficult budget choices of where policymakers will choose to allocate their funds, and we have inflation. The cost of building materials is rising by double-digits. That means a dollar of public works builds less than it used. The $1 trillion federal infrastructure package is likely to fully fund fewer projects than originally expected.

Posted by: Josh Lehner | June 2, 2022

Inclusive Economic Recovery

Our economy, and our society have long-standing disparities that remain today. The good news so far this cycle is that when it comes to employment trends and opportunities by age, gender, geographic location, and race and ethnicity, these disparities are not wider today than they were before the pandemic hit. That makes this recovery inclusive, or at least more broadly shared than past recoveries.

That said, two other disparities have widen. Wealth inequality has increased. Even as incomes and wealth have increased across the board, the gains are larger among the upper end of the distribution. This is particularly true for homeowners given the record-setting home equity gains experienced during the pandemic. The gap between the haves and have nots is larger today than two and a half years ago.

The second disparity that widened during the pandemic is employment by educational attainment. Given the nature of the pandemic shock and shutdowns, it was the in-person service industries that bore the brunt of the layoffs. Such positions are disproportionately filled by workers with lower levels of educational attainment. Employment for college graduates barely changed other than some are now working remotely to a greater degree.

The encouraging news today is these educational attainment disparities are lessening. Job growth has been strongest among the hard-hit service sectors. Moving forward a full recovery is expected. Job growth will be more balanced across sectors and based on underlying economic and consumer spending patterns rather than pandemic-related forces.

Finally, it is true that some employment disparities by sex, and race and ethnicity did widen initially in the pandemic. However, they have now closed. Looking at national data, employment trends for Asian, Black, Hispanic or Latino Americans are each a percent or two stronger than for white Americans. In terms of employment by sex, nationally men are a few tenths stronger than women, while here in Oregon trends for women and men are identical. Even the parent gap has effectively closed. Employment rates for moms with young children at home have caught up to the broader labor market trends. Dads are still outperforming by a percent or so, but moms are no longer lagging the overall economy.

None of this means that everything is fine. We have long-standing disparities that remain. And even as the racial poverty gap and urban-rural divide narrowed initially, we know some of that had to do with the large federal aid earlier in the pandemic. From that view, it is possible that those disparities will widen a bit in 2022 and 2023, returning to their pre-pandemic differences. Time will tell. But for now, the fact that the current, strong labor market recovery has also been inclusive is encouraging.

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